Even during best of times, economies are subject to fluctuating economic activity, known as business cycles. But the Great Recession from which the nation is recovering so slowly was more than an ordinary vanilla business cycle.
A partial list of measures to return to prosperity includes international trade policies more favorable to American workers, policies that ensure that gains from increased productivity reach the middle class, and restored confidence and integrity of our largest financial institutions. These will require some major political heavy lifting.
The more immediate tools of the federal government available to stabilize the economy are monetary and fiscal policy. Monetary policy consists of the availability of money and credit, implemented by the Board of Governors of the Federal Reserve System headed by Ben Bernanke (see my column of Sept. 21, 2012). Fiscal policy is the federal government's powers of taxing and spending, implemented by the president and the Congress.
An economic recession calls for expansionary monetary and fiscal policies. During a mild recession an expansionary monetary policy with reduced interest rates and easier access to credit to encourage borrowing and spending may be sufficient to goose the economy. But monetary policy alone could not be expected to get us out of the Great Recession.
Interest rates are not generally the major factor in spending decisions. Consumers with weak balance sheets and uncertain employment cannot and should not make large spending commitments. And while the interest rate is a factor, the chief decision criterion for business borrowing and spending is ultimate anticipated payoff from the expenditure; and that depends on demand for product. Monetary policy alone won't do it.
This is where counter-cyclical fiscal policy and aggregate demand comes in. The level of national economic activity depends on the level of spending. If this sounds profligate, think of receipts - aggregate expenditures equal aggregate receipts.
During recession, consumer spending is down; so is private investment. Plant capacity is idle; so are workers. This is wasteful - the goods and services that could be produced, but are not, even as workers want employment and the income with which to buy stuff that isn't being produced, but could be. Economists call this the GDP gap, the difference between what a fully employed economy could produce, and the reduced amount actually produced.
The federal government has the power to fill the gap through expansionary fiscal policy; some combination of reduced taxes and increased spending to increase aggregate demand. The increased spending ideally should be: 1) on projects that immediately employ domestic labor, 2) on projects that require other local and domestic inputs, thus generating a multiplier effect, and, 3) on projects that need to be done anyway, and which increase the ultimate efficiency of our national economy. Construction on roads, bridges, rail, improved water, sewer, and environmental projects, and improved energy-efficient buildings meet these criteria.
Tax cuts also are expansionary in the sense that more money is left in the hands of consumers. However, economists see, dollar for dollar, government expenditures as generating more employment. Here's why. That extra dollar spent on a construction project is immediately spent, and circulated throughout the economy. That extra dollar in a tax cut, especially for a wealthy individual, may not be spent. Or, if spent at a big box store for stuff made in China, doesn't do much for domestic employment.
Am I against saving? Hey, c'mon, I'm Swiss. Strengthening household and business balance sheets is the responsible thing to do. But if we're talking measures to increase employment, we have to get the money circulating immediately. Unemployed workers can't save, and don't have the dough to create the demand that gives businesses incentive to employ more people.
During recession, the federal government will - and should - run a deficit. Its size is problematic, but not for reasons commonly stated. A federal deficit will occur during recession because of reduced tax revenues due to reduced incomes, profits, and economic activity. And, if additional federal expenditures are deliberately made to compensate for deficient private spending, this may temporarily increase the deficit, but not necessarily much, especially relative to the size of the economy. How can this be?
Unemployed people can't pay income taxes, or make the typical expenditures of fully employed people. To compensate, government expenditures, whether for defense contracts, road construction, aid to local government for police, schoolteachers or anything else, increase employment, economic activity, and tax revenue - keeping money circulating in the economy.
To put it another way, political rhetoric to the contrary, during recession, cuts in federal spending will not reduce the deficit simply because reduced spending further reduces employment, economic activity, and federal tax revenue. If you don't believe this, witness the hue and cry from a congressman whenever there is a threat to close a military base or defense contract in his/her district.
Does all this mean that we will forever have to increase our public debt to maintain full employment? No, but here is the problem - more political than economic.
The flip side of an expansionary fiscal policy during recession is to run a contractionary fiscal policy during good times, and to reduce the size of the deficit relative to the size of the economy, or even in absolute terms. If the budget surpluses accumulated during the Clinton years had been used to reduce the public debt, politicians would now have the political cover with which to institute the expansionary fiscal policy that is now urgently needed.
As a practical matter, the logical goal now is to increase employment with the tools at hand, including fiscal policy. This would reduce the federal deficit relative to the size of the economy and enable longer run steps to keep it within manageable proportions.
Again, there are other steps needed to get the economy back to long run growth. But proper monetary and fiscal policies are the immediate need.
A partial list of measures to return to prosperity includes international trade policies more favorable to American workers, policies that ensure that gains from increased productivity reach the middle class, and restored confidence and integrity of our largest financial institutions. These will require some major political heavy lifting.
The more immediate tools of the federal government available to stabilize the economy are monetary and fiscal policy. Monetary policy consists of the availability of money and credit, implemented by the Board of Governors of the Federal Reserve System headed by Ben Bernanke (see my column of Sept. 21, 2012). Fiscal policy is the federal government's powers of taxing and spending, implemented by the president and the Congress.
An economic recession calls for expansionary monetary and fiscal policies. During a mild recession an expansionary monetary policy with reduced interest rates and easier access to credit to encourage borrowing and spending may be sufficient to goose the economy. But monetary policy alone could not be expected to get us out of the Great Recession.
Interest rates are not generally the major factor in spending decisions. Consumers with weak balance sheets and uncertain employment cannot and should not make large spending commitments. And while the interest rate is a factor, the chief decision criterion for business borrowing and spending is ultimate anticipated payoff from the expenditure; and that depends on demand for product. Monetary policy alone won't do it.
This is where counter-cyclical fiscal policy and aggregate demand comes in. The level of national economic activity depends on the level of spending. If this sounds profligate, think of receipts - aggregate expenditures equal aggregate receipts.
During recession, consumer spending is down; so is private investment. Plant capacity is idle; so are workers. This is wasteful - the goods and services that could be produced, but are not, even as workers want employment and the income with which to buy stuff that isn't being produced, but could be. Economists call this the GDP gap, the difference between what a fully employed economy could produce, and the reduced amount actually produced.
The federal government has the power to fill the gap through expansionary fiscal policy; some combination of reduced taxes and increased spending to increase aggregate demand. The increased spending ideally should be: 1) on projects that immediately employ domestic labor, 2) on projects that require other local and domestic inputs, thus generating a multiplier effect, and, 3) on projects that need to be done anyway, and which increase the ultimate efficiency of our national economy. Construction on roads, bridges, rail, improved water, sewer, and environmental projects, and improved energy-efficient buildings meet these criteria.
Tax cuts also are expansionary in the sense that more money is left in the hands of consumers. However, economists see, dollar for dollar, government expenditures as generating more employment. Here's why. That extra dollar spent on a construction project is immediately spent, and circulated throughout the economy. That extra dollar in a tax cut, especially for a wealthy individual, may not be spent. Or, if spent at a big box store for stuff made in China, doesn't do much for domestic employment.
Am I against saving? Hey, c'mon, I'm Swiss. Strengthening household and business balance sheets is the responsible thing to do. But if we're talking measures to increase employment, we have to get the money circulating immediately. Unemployed workers can't save, and don't have the dough to create the demand that gives businesses incentive to employ more people.
During recession, the federal government will - and should - run a deficit. Its size is problematic, but not for reasons commonly stated. A federal deficit will occur during recession because of reduced tax revenues due to reduced incomes, profits, and economic activity. And, if additional federal expenditures are deliberately made to compensate for deficient private spending, this may temporarily increase the deficit, but not necessarily much, especially relative to the size of the economy. How can this be?
Unemployed people can't pay income taxes, or make the typical expenditures of fully employed people. To compensate, government expenditures, whether for defense contracts, road construction, aid to local government for police, schoolteachers or anything else, increase employment, economic activity, and tax revenue - keeping money circulating in the economy.
To put it another way, political rhetoric to the contrary, during recession, cuts in federal spending will not reduce the deficit simply because reduced spending further reduces employment, economic activity, and federal tax revenue. If you don't believe this, witness the hue and cry from a congressman whenever there is a threat to close a military base or defense contract in his/her district.
Does all this mean that we will forever have to increase our public debt to maintain full employment? No, but here is the problem - more political than economic.
The flip side of an expansionary fiscal policy during recession is to run a contractionary fiscal policy during good times, and to reduce the size of the deficit relative to the size of the economy, or even in absolute terms. If the budget surpluses accumulated during the Clinton years had been used to reduce the public debt, politicians would now have the political cover with which to institute the expansionary fiscal policy that is now urgently needed.
As a practical matter, the logical goal now is to increase employment with the tools at hand, including fiscal policy. This would reduce the federal deficit relative to the size of the economy and enable longer run steps to keep it within manageable proportions.
Again, there are other steps needed to get the economy back to long run growth. But proper monetary and fiscal policies are the immediate need.
